Benchmarking: Part 3

You might have noticed, but we really want to see your business succeed from information gained through benchmarking. In other words, we want you to be a pro. But, before we unleash you to get started, we need to share a few things to avoid when you start a benchmarking analysis.

  • Comparing Company A to Company B: Make sure the peer group that you’re comparing to the business is representative of the industry. Comparing yourself to another, single company, can prevent you from seeing a true comparison if there are considerable differences. If you are looking at a benchmark analysis that restricts the sample size to only one other company, be critical in your findings.
  • Be aware that the benchmark analysis doesn’t end with a variance report: Once your report reaches the variances between its financial metrics and its peer group benchmarks, you might think you’re finished, but the work is just beginning. Don’t get worried — as the work is just beginning, so are the opportunities! When viewing the variances of your report you are now given potential problem areas to fix and also the opportunity to improve the overall performance of the company. For example, the variance report shows the areas of the business that are excelling. Now that you can see the areas of your company that have successes, see if this strategy can be implemented in other areas of the company.
  • Assume that numbers and performance are always changing: Positions in a car race are constantly shifting: first to third, second to last and so on. It isn’t optimal to compare your business to its peers only once per year, since many industries are always changing, even if your business isn’t. By preforming frequent benchmark analyses, your business can identify trends and react sooner.
  • Be mindful with calculations and the conclusions drawn from them: Certain benchmarks are common financial measurements (turnover rations, net profit margin, and liquidity rations) and their calculations generally do not change. If your benchmark analysis is expanded to include industry specific key performance indicators (KPIs) (airline-sales per seat, for example), make sure to use the same calculations, period after period. However, if a subaccount is added for one period but then removed the next period, the trend analysis performed might be misleading.
    • All members of management and the financial team need to understand the definitions of the metrics, and have a copy of them as well. You want to make sure there is only one interpretation, which will help defuse any confusion. Be sure everyone is on the same page to allow for complete and easy understanding.

It may not seem like a must do task, but benchmarking is important. When it comes down to it, remember the true purpose of benchmarking: to illuminate successes and challenges for your company, and to give you, the business owner, insights to inspire action!

*Shameless plug: If benchmarking sounds like the thing for you, let us know. We love helping businesses see how they’re doing!

 

Benchmarking: Part 2

In our latest blog post, we looked at why benchmarking is important for your business. Some of those reasons include:

  • It keeps you up to speed with real-time data (that is, as long as the data is timely, relevant, and accurate).
  • It never goes out of style and can be used continually, rather than a one-and-done solution.
  • It truly helps you understand the well-being of your business situation.

So now that we have a refresher of why benchmarking is great for your business, let’s dive in deeper. After you decide which data source you’ll use (make sure it’s accurate, timely and relevant), the challenge is now deciding which benchmarks to analyze and use as a tool for the success of your business.

We’ve said it before, but we will mention it again. Different industries, and different companies within an industry, might have different success measures. For example, a contractor might have large subcontractor expenditures. Are these expenses normal considering the contractor’s sales volume?

Instead of taking a look at industry-specific metrics, we’re going to focus on some metrics that are universally important and can provide a quick look into a company’s health.

  • Liquidity Ratios. Yes plural – because there are two that need to be analyzed together. They are:
    • Current Ratio which is shown as current assets divided by current liabilities. This metric shows general liquidity, but it does have some limitations. If inventory is included in calculating the current ratio, it might provide a distorted understanding of your cash flow.
    • Quick Ratio is expressed as cash accounts receivable divided by current liabilities. This ratio might not be perfect for showing liquidity, but it can be a useful and popular comparison to pair with the current ratio.
  • Net Profit Margin. Expressed as net-profit before taxes in a given period divided by sales. Another way to view this? How many cents of profit you extract from each dollar you earn in revenue. This might be a basic metric, but it’s extremely important!
  • Turnover Ratios. There are three ratios that you should consider:
    • Inventory Days which is shown as inventory divided by cost of goods sold, multiplied by 365 days. Inventory days tells the story of how long it takes to sell off inventory. However, it’s important to remember this ratio is very industry-specific. Imagine how long wine is stored in a winery compared to the length of time milk sits in a grocery store cooler. Usually, lower numbers are better.
    • Accounts Payable Ratio is expressed as accounts payable divided by cost of goods sold, multiplied by 365 days. The accounts payable ratio shows the number of days you take to pay the vendors. Higher numbers are better – it means you hold on to cash longer.
    • Accounts Receivable Ratio is shown as accounts receivable divided by sales, multiplied by 365 days. This is a rough measure of the number of days your company takes to turn accounts receivable to cash. You want lower numbers, as it is better to have cash in the bank than extra receivables on the books.

By paying attention to some of these important metrics, you can build a picture of where your business Is, where it should be going and what it will take to get there.

Benchmarking: Part 1

Do you ever wonder how your business does compared to others similar to you in size and industry? Maybe knowing this information would give you a more competitive drive, or would lead you to make some improvements to better your company. Or, maybe you’re just curious.

Whatever your reason for wanting to know, benchmarking can be a powerful tool to compare you to your peers and check your performance. Benchmarking can even lead to an overall greater level of success as a company.

Here are a few (of many) reasons why we think benchmarking is pretty awesome.

It never goes out of style| Benchmarking isn’t just a one and done concept. It can, and should, be used throughout the entire lifecycle of the business. As your numbers and statistics change, the same happens for the competition. Benchmarking can provide a real-time look into how your business is stacking up against the competition and industry trends, and can help you find solutions at any stage in your business.

Knowledge is power| When you see and understand how your business is ranking relative to similar businesses, you can empower management to evaluate company performance and make informed decisions. This information can also be used to identify new and future opportunities that can lead to greater growth and success. To accomplish this, it’s best to compare on an industry or peer group level, rather than just a one-company comparison.

Data doesn’t lie| Without good data, you’re wasting your time. Make sure to look for data from benchmarking that is:

  • Relevant – Data won’t mean much to you if it isn’t relevant to your business. Make sure you consider your geography, size and industry when getting your data. Each has their own trends and characteristics that are incorporated into the data – which makes for a meaningful comparison.
  • Timely – You want to be sure the benchmarks being used are the most recent available, which helps account for seasonality, economic cycles and other fluctuating factors.
  • Accurate – If you’re making sure your data is relevant, it will likely be accurate too. However, it’s always a good idea to verify the data before applying to make important decisions.

A way to measure success| Each business and industry (even businesses in the same industry) has a different way of measuring what success means to them. While you can only decide what success looks like for your business, there are a few metrics that can provide a quick, high level view of your business’s well-being:

  • Net Profit Margin = Net profit before taxes, divided by sales
  • Liquidity Ratio – Current Ratio = Total current assets divided by total current liabilities
  • Turnover ratios, which include inventory days, accounts receivable days and accounts payable days.

As you can see above, benchmarking is a great way to get a picture of how your business is really doing compared to those around it. Using this information, you can feel comfortable making changes to better grow and improve your business.

Benchmarking 103: Pitfalls to Avoid

While we think you really should be benchmarking (come on, how else will you know how you rate?), we also feel the obligation to tell you about some things to avoid when starting a benchmarking analysis. We’re nice like that.

  • Comparing Company A to Company B: Comparing your business to a peer group is helpful if the peer group is representative of the industry. However, if you begin to compare yourself to another, single company, there may be considerable differences that prevent true comparisons. Look critically at any benchmark analysis that restricts the sample size to only one other company.
  • Be careful with calculations and conclusions drawn from them: certain benchmarks (net profit margin, liquidity ratios, and turnover ratios) are common financial measurements, and their calculations are not generally refuted or changed. However, if you expand your benchmark analysis to include industry-specific key performance indicators (KPIs) (restaurant-sales per seat, for example), be sure to use the same calculation, period after period. If a subaccount is included for one period but then excluded for the next period, any trend analysis performed could be misleading.
    • Once definitions for the metrics are determined, be sure that all members of management and the finance team have this set of definitions. Also, be sure they understand what the metrics mean. There should only be one interpretation.
  • Assume that numbers and performance are always changing: Positions in a horse race are constantly shifting: first to third, fourth to last and so on. Comparing your business to its peers only once per year may not be optimal, given that the industry is always changing, even if your business isn’t. The more frequent the benchmark analysis is performed, the sooner the business can identify trends and react.
  • Recognize that the benchmark analysis doesn’t end with a variance report: Though it may seem that the work is complete once you have compiled a report showing variances between its financial metrics and its peer group benchmarks, the work is actually just beginning. And so are the opportunities! Each variance gives you a potential problem area to fix and the opportunity to improve the company’s overall performance. The variance report will show in which areas the business is really excelling. Take pride in these success, and see if the winning strategy can be implemented in other areas of the company.

Remember: the objective of benchmarking analysis isn’t to build a benchmark report. The objective is to illuminate successes and challenges for the company and give business owners actionable insights!

Benchmarking 102: Prioritizing Benchmarks

In a previous blog, we learned WHY benchmarking is so important. Here’s a brief refresh:

  • It helps you understand your situation.
  • It can be used continually. Benchmarking is not a use it once and pitch it solution.
  • It provides you with real-time data. That is, as long your data is accurate, timely and relevant.

So now that we’re all up to speed, let’s revisit benchmarking again. After securing the accurate, timely and relevant data source you’ll use, the challenge becomes choosing which benchmarks to analyze and use as a proxy for business success.

Different industries, even different companies within an industry, could have different measures of success. For example, a contractor may have large subcontractor expenditures. Are these expenses normal considering the contractor’s sales volume?

Rather than define all these industry-specific key performance indicators (KPIs), we’re going to focus on a few financial metrics that are the most universally important to business and, when analyzed together, provide a quick and high-level review of a company’s health. Get excited.

  • Net Profit Margin. Generally expressed as a net-profit before taxes in a given financial period divided by sales. Another way to look at it is how many cents of profit you extract from each dollar it earns in revenue. This may be a rudimentary financial metric, but it is also the most important!
  • Liquidity Ratios. Did you note the plural usage? Good because there are two that need to be analyzed jointly.
    • Current Ratio is expressed as current assets divided by current liabilities. This metric shows your general liquidity, however it has some limitations. By including inventory in the calculation, it may provide a distorted understanding of your very short cash flow.
    • Quick Ratio is typically expressed as cash accounts receivable divided by current liabilities. Again, this ratio may not be perfect for gauging liquidity, but it is a useful and popular comparison to pair with the Current Ratio.
  • Turnover Ratios. Plural again … because there are three this time to consider:
    • Accounts Receivable (AR) is expressed as accounts receivable divided by sales, multiplied by 365 days. It roughly measures the number of days your company takes to turn accounts receivable into cash. Lower numbers are more desirable since it is better to have cash in the bank than extra receivable on the books.
    • Accounts Payable (AP) is expressed as accounts payable divided by cost of goods sold, multiplied by 365 days. The accounts payable ratio indicates the number of days you take to pay its vendors. Here, higher numbers are better as it means you are able to hold onto cash longer.
    • Inventory Days is expressed as inventory divided by cost of goods sold, multiplied by 365 days. Inventory days measures the number of days it takes to sell off inventory. As a note, this ratio is very specific to the industry. Imagine how long wine is stored at a winery compared to how long eggs are on grocery stores shelves. Generally, lower numbers are better.

By using some of these financial metrics repeatedly, you can being to build a picture of where your business should be going, where it’s excelling and where you can change and improve.

Understanding Your Financials

financial statements

Running a business full time is a lot of work. Not only are you running the company, you’re attempting to keep employees happy (if you have them), trying to get the word out about your business, and on top of that, trying to manage your finances. Who has time to truly understand the financials and what they mean?

We think understanding your financial statements is key to effectively running your business and making smart decisions. Your financial statements can shed light on areas of your business and can help you identify areas for growth and for improvement.

Your financial statements tell the story of your business, where it has been, where it currently sits and where it’s headed. Don’t believe us? Here are a few examples of things your financial statements can tell you.

The balance sheet tells you about the resources (or sometimes lack of resources) in your business. This financial statement is measured at a point in time (as compared to a period of time). Here are some of the measurements the balance sheet is responsible for telling you:

  •  How much cash do you have?
  • What is the net book value (NBV) of any property and equipment you are holding for business use? NBV…that is the original cost less depreciation.
  • How much do people owe you? How much do you owe others?
  • How much is left in your business after all your liabilities are taken care of (a.k.a equity)?
  • How much of your business is financed by long-term debt versus financed by you (or any partners you might have)?
  • Speaking of long-term debt, what principal portion of that debt is due within the next year?
  • What is your ability to pay your current liabilities with current assets (aka working capital)? No so fast, what’s makes them current? Typically current liabilities and assets are those that are expected to be paid or consumed (or received in the case of accounts receivable) within the next year.

The income statement tells you about the profitability (or again sometimes lack of profitability) of your business. This financial statement is measured for a period of time, such as a month, quarter or year. Here are some of the measurements the income statement is responsible for telling you:

  •  What was the gross margin for the period (gross income – cost of goods)?
  • What were your operating expenses for the period?
  • What was the net income for the period (gross margin – operating expenses – other income/expense)?

In addition if you are tracking your income and expenses by profit centers (ex. job, department, product line, etc.), you would be able to see all of the above measurements by those profit centers. This is especially valuable as it helps determine where you are making money or losing money.

The statement of cash flows tells you about the sources and uses of your cash. In other words where did it all come from and where did it all go?

Now the really good stuff…

You can take your financial statements to the next level by comparing your current performance against historical performance, benchmarking yourself against your industry and peers, and projecting your future performance.

  • You against you…viewing your financial statements historically allows you to see changes in balances and trends in your performance (good or bad).
  • You against the industry….viewing your financial statements against industry data or standards allows you to see how you stack up. Where are you better than the industry or where can you improve compared to the industry?
  • Projecting your future…projecting where you see yourself financially can be a valuable tool in budgeting your expenditures and managing your business. The most valuable projections are done on a rolling basis, meaning the projections are changing as your business changes. Projections that are only looked at on an annual basis do not provide as much value.

To wrap it all up, financial statements provide a wealth of information for you to make more informed decisions about your business. Knowing and understanding where you stand financially can mean the success or failure of your business.

 

 

Trick or Treat: A Spooky Accounting Lesson

Halloween blogIt’s the scariest time of the year. With Halloween just around the corner, many people are facing their fears, whether it be goblins, ghouls or your kids eating too much sugar. But what you might not be thinking of is accounting. Or, more importantly, the fear that lack of accurate and correct financial data can cause.

Yes, I know numbers can be scary. Trust me, as the non-numbers person in an accounting world, I understand your trepidation. However, without useful data and accurate financials, your company could be in for a world of hurt worse than your “I just ate all the Halloween candy in one sitting” gut ache.

Here are four scenarios we commonly come across and the truth (or trick) behind them:

1. I don’t need accounting staff. I can do it all by myself.

TRICK: You’ve branched out and started your own business. You’re now your own boss and you can do it all! Right? Wrong. We often see companies who attempt to do it all on their own. The result? They have books they don’t understand and end up just entering numbers into a spreadsheet without making sense of them.

The problem with this is two-fold. One, it’s frustrating. When you don’t understand the basic financial state of your organization, let alone how much money you’re making (or losing), it can be hard to run a business. Second, solid financial data is essential in understanding where your business is currently and where you’re hoping to go in the future. Plus, potential creditors, investors and buyers like to see the numbers.

The solution? Hire qualified accounting staff. Ideally, this will be at least two people (possibly more, depending on the size of your organization): A bookkeeper to handle the day-to-day administrative financial functions of your organization and a controller/CFO/senior level financial professional to give you strategic direction and guidance. Don’t have the resources right now to make the hire? Outsource it.

2. My books show I’m profitable, so I must be in good shape right?

TRICK: Just because your books say there’s money coming in, doesn’t mean that you’re in the clear. Cash flow and profit are two different things. You need to keep a watchful eye on your company’s inflows and outflows, as well as your investments, purchases, etc. That’s why it’s important to take a look at your finances more than once a year. Ideally, you should be reviewing your financial statements monthly to ensure you not only understand your current situation, but also potential pitfalls to avoid.

3. I like to benchmark myself to ensure I’m keeping up with my competition.

TREAT: Benchmarking is an excellent way to keep tabs on the health and wellbeing of your company. It can help you assess performance and see how you compare to your peers. Further, it can help you gauge your current status and implement changes to help grow your organization.

Bonus tip (don’t you love getting two pieces of candy?): Not only should you be benchmarking your organization, but you should also be forecasting. This essentially means mapping your future into something banks and potential investors can relate to. Think profitability, growth rate and future capital needs.

4. I only meet with my accountant once a year … at tax time.

TRICK: Yes, it’s essential to see your accountant at tax time. After all, we all have to do taxes. However, by only seeing your accountant once a year, you’re missing out on the other services they can provide, including tax planning, reviewing your financials and helping you plan for the future.

The numbers may scare you and the subject may make you cringe, but a good accountant will help walk you through your financial data and ensure that you have the information you need to make decisions now and in the future for your organization.